Crime, punishment and tax

This article studies the effects of income taxation on enforcement of business regulations. The key result is that income taxation makes it less socially costly to enforce the law and therefore allows the attainment of a higher level of deterrence. The explanation for this result is that income taxation reduces the gains businesses derive from violating the law, but it does not affect, at least not to the same extent, the feasible fine. This result is true, regardless of whether fines are deductible for tax purposes or not, as long as the probability and magnitude of fines optimally reflect tax rules and tax rates, as this article argues they should do. However, if the probability and magnitude of fines do not change in response to income tax changes, disallowing deductions for fines, which is the prevailing tax rule in many jurisdictions, is socially desirable for sufficiently low tax rates or tax rate changes.